Post New

All calculated for today (9 Feb).

Current Shiller PE Ratio: 29.91
Mean:	17.00	(1870-today)
Median:	15.91	
Min:	4.78	(Dec 1920)
Max:	44.19	(Dec 1999)

The Shiller PE (also called CAPE ratio) uses the 10 year average earnings adjusted for inflation, and compares to the same calculation made throughout the past so that the year-to-year noise can be largely cancelled out. On this measure, the S&P500 is now valued at 30, versus the median value of 15, so exactly twice as expensive.

To reach the last minimum value for the Shiller PE ratio again, the S&P500 would need to fall 84%. Unlikely, but I thought I'd just remind what has occurred in the past for those taking on margin debt.

Current S&P 500 PE Ratio (ttm): 22.01
Mean:	15.99 	(1870-today)
Median:	14.91	
Min:	5.31	(Dec 1917)
Max:	123.73	(May 2009)

Looking back to 1870 again, and considering just the plain PE ratio, we are 22/16 = 47% above the norm, however earnings are still rather elevated (which is why many prefer to use the Shiller PE ratio) so we are likely more than 47% above the norm if we adjust the present earnings down a little. Keep in mind that real earnings of the S&P500 grew by less than 2% per year over the last century. Most of the wealth provided to shareholders was always via dividends, with the capital gains on average barely keeping ahead of inflation. Very few view the past (and certainly not the present) in this way, but probably should.

As a sanity check, the sales per share of the S&P500 from over the last 22 years from $750 to $1714, which is an average annual return of 3.8%. That approximately matches the whole-period inflation, which means that real sales have remained unchanged since 2001. The value paid out to shareholders was via the dividends along the way. There have been capital gains over the last two decades, but much of the capital gains are accounted for by an increase in the valuation over that period, rather than the real intrinsic value increasing (you can use the sales per share as a rough proxy for the underlying normalised value of the S&P500 in the time-relative sense).

Over the last 22 years there has been a one-time large increase is corporate margins, so the growth in earnings per share has faired much better. However we can go from lower margins to higher margins, but you should not bet on going from the current high corporate earnings to even higher (much higher) corporate earnings 20 years into the future, which would be required if you want to see the same eps growth as you are accustomed to. If the current high corporate margins are merely sustained, then expect a lower eps growth than you are accustomed to seeing. If they return to where they were, expect large real earnings per share declines.

Current S&P 500 Price to Book Value: 4.13
Mean:	2.96	(2000-today)
Median:	2.81	
Min:	1.78	(Mar 2009)
Max:	5.06	(Mar 2000)

The price to book value is a completely different way of looking at the valuation, and on this measure we are also 47% overvalued compared to the data back to 2000 (which is a period that on the whole has been a fairly optimistic, and thus low yielding). Price to book values have been much lower prior to 2000.

The commonly cited total return of the S&P500 over the long-term is about 6-7% after inflation, made popular by Jeremy Siegel, however that assumes (1) we are starting from an average valuation, (2) the next 20 years from here covers similarly highly accommodating pro-business policies, and we have no more energy constraints than we had in the past. I believe 2 is likely to cause substantially lower returns, though most don't pay attention to it, but everyone should at least pay attention to 1, and then adjust your expectation of long-term forward returns accordingly. Combining 1 and 2 has an elevated effect.

If you believe we need a 40% downwards revision in the S&P500 quote to reach an average baseline, and you are still going to get your full 6.5% over the long-term, then you need about 8 years of no returns whatsoever to catch up. (1/1.065^8-1 corresponds to a 40% fall).

Stocks returning 6.5% real is a statistic with many premises. Statistics may lie when simplified, but they don't tend to lie when expanded carefully, and the epistemology is reflected upon. If you really want something, one can start to believe it is true, but that usually doesn't make it true.

Having said that, provided one's expectations are sufficiently low, then investing can remain alive and well. It is when expectations greatly exceed the central likely outcome that planning problems (especially when debt is involved) can become inconvenient!

- Manlobbi

I haven't really studied the individual companies that comprise the index but cant one assume that the S&P 500 is not as overvalued as above suggests, given the companies that make up the top 30pct?
Goog and meta, once cash is netted out trade at more reasonable PEs (havnt looked at Msft or apple but assume the same)and berkshire's numbers are heavily distorted.

Wonderful, thought provoking and sobering post, Manlobbi. Thank you. Reminded me of Chris Bloomstran and his 2021 Semper Augustus letter looking at the breakdown of S&P returns for the decade ending 12-31-21. All things rationally considered, he thinks S&P annual expected return will be around 5% over the next decade. Excerpt:

'The largest return driver over the decade was an expansion in the P/E multiple from 13.0 to 23.6 times, an 81.1% increase and annual growth of 6.1%. Here it is important to note that it is not correct to infer that 6.1% of the 16.6% return came from multiple expansion. Remember, the derivation of return is multiplicative. Simply adding across can get close but will not be correct. By attributing each of the five components as a percentage of the return can you then get to a contribution from each. Thus, the index earned 6.4% annually just from multiple expansion alone.
The balance of return was closely split between 3.8% annual growth in the profit margin and 3.7% growth in sales per share. The profit margin grew from what was already a record 9.2% to a new record 13.4%. To get to one of the best 10-year periods of all time, you'd customarily expect to see some combination of margins and multiples rising from a depressed base. A 4% margin and an 8 multiple to earnings in 1982 would be a perfect example here, as that was the launch point for the great 18-year bull market that ensued, when the multiple grew from 8 to 33 and the margin from 4% to 7.4%.
I ask lots of professional investors how fast sales per share and overall dollar sales grew annually for the past decade and two decades. Most guess wildly high. For the past decade, presumed strong by most observers since stocks retuned 16.6%, sales per share grew 3.7% annually, but sales only by 3.0% in dollar terms. A reduction in the overall share count at an annual rate of 0.7% helped the overall return. If one considers that companies spent more than all their profits (augmented with an increase in net debt) not paid as dividends repurchasing shares, perhaps that's what's driven the ballooning of the P/E multiple? This will be seen in reverse when examining the decade ending in 1999 when the share count ballooned, repurchases not yet much of a thing. Either way, executives got rich.
Using very rosy assumptions, an investor concluding that the profit margin at 13.4% will be the peak and the 23.6 multiple (an operating earnings yield of 4.2%) will likewise grow no higher will be left with growth in sales per share plus the dividend yield. Adding 3.7% expected growth in per share sales to today's puny and near-record-low 1.3% dividend yield arrives at a 5.0% annual expected return over the next 10 years.
The CIO expecting a 10% return from the index, presuming sales per share growth of 3.7% and our initial dividend yield of 1.3%, requires some combination of 4.8% annual growth in the margin and the multiple (remember from the formulas above, one must multiply rather than add the growth in sales per share, margin, and multiple). Split evenly, at just less than 2.4% annual growth, the profit margin grows to 16.9 and the P/E multiple to 29.8. Holding the margin at today's peak 13.4% requires a 37.7 P/E multiple. These are bets I wouldn't take, and if the job depends on attaining a return expectation, one really needs to think long and hard about these assumptions.'

Superb post as usual, thank you!

I like to keep an eye on the 'Buffett Indicator' (ratio of total market cap to GDP) which Warren has described as, 'the best single measure of where valuations stand at any given moment.'
It currently stands at about 160% of GDP.
'If the percentage relationship falls to the 70% or 80% area, buying stocks is likely to work very well for you.
If the ratio approaches 200% as it did in 1999 and a part of 2000 you are playing with fire.' ~Warren Buffett

Fires all go out eventually...
All the best!

https://www.gurufocus.com/stock-market-valuations....

Great post by Manlobbi, reinforcing what Munger, Grantham and others have been saying in terms of current market overvaluation.

"I like to keep an eye on the 'Buffett Indicator'"

If one wants "time in the market" as opposed to "timing the market", perhaps a long term investment in Berkshire (~20% undervalued) makes more sense than the S&P 500 (~47% overvalued)?

Not that Berkshire won't go down with the overall market in a severe correction. In which case have some cash on hand to buy more.

Comments?

Manlobbi,

You are one of my favorite all time posters on any message board and hate to disagree with you. But here it goes

1. You says sales increased by 3.8% and roughly matches inflation. So no real sales growth. The composition of the sales changed quite a bit. Grocery/department stores sales cannot be weighted the same as say iPhone, Google Ads, Amazon 2P sales, etc.

2. The same goes for profit margins.

3. You say much of the value was via dividends. Now a lot more is retured via stock buybacks even after accounting for options. Real EPS did not grow much in the past and Arnott I think calculated it at 0.7% per year. But now with buybacks this several multiples of that number.

4. 6.5% real returns were during a period of time when there are impossible for anyone to earn those kinds of returns. In the 1920s, 40s etc. there is no way anyone can buy a diversified portfolio of stocks at a low cost. They have to take a train and go to a brokerage and have to rely on financial data that is difficult to get, less disclosure, etc. Basically the cost to implement a diversified portfolio would have been more than 2% or so annually. So stocks did give 6.5% real but no one actually got them after considering costs. Now anyone can get market returns at near zero cost. So why should stocks still give 6.5% real returns?

5. Until the 1950s people thought stocks must have higher dividend yield than bonds because stocks are riskier. But they wised up as they realized that stocks dividends grow. Similarly people have realized the advantages of stocks and everyone and their dog knows that stocks are a primary building block of retirement portfolios. There is a huge industry that developed to educate, provide automatic workplace retirement plans, etc. Now I dont think people would need as much equity risk premium as in the past. Instead of 6.5% they might settle for 4%. So valuations can and should be higher than the past.

1. You says sales increased by 3.8% and roughly matches inflation. So no real sales growth. The composition of the sales changed quite a bit. Grocery/department stores sales cannot be weighted the same as say iPhone, Google Ads, Amazon 2P sales, etc.

Very true. These new business models have higher profit margins, so this observation aligns with the general higher profit margin observation. However the positive trend in profit margins can reverse also, as strong moat business models with high pricing power only have finite tolerance to competition, as special each new era feels. For example, Alibaba has been purchasing low margin business over the last few years, essentially barely profitable infrastructural and other physical-economy purchases, to retain their competitive edge.

We have become accustomed to a lot of pro-business trends and part of my post was to not take that for granted as continuing to trend in the same direction, but potential heating at the current level. Even halting these trends (not reversing but retaining present policies) would result in lower EPS growth than we are accustomed to observing and may simply take for granted as normal.**

3. You say much of the value was via dividends. Now a lot more is retured via stock buybacks even after accounting for options.

The buy-backs were accounted for in this sales growth as the sales data I gave were for the per-share sales growth rather than the total sales growth.

6.5% real returns were during a period of time when there are impossible for anyone to earn those kinds of returns.

I agree that it is rational for stocks to be priced a little higher because of the lower brokerage costs (our nominal return being lower, but the after-cost return not being so bad). This still results in lower earnings yields (and lower dividend yields) than the past, because of the lower brokerage costs, so business making purchases between each other must also accept the lower returns. Think carefully about the conclusion, though. If we accept the higher prices (and lower earnings yields, and lower dividend yields) as rational both today, and into the future, then our returns will be, by mathematical observation, lower than the past 6.5% with other factors unchanged.*

Until the 1950s people thought stocks must have higher dividend yield than bonds because stocks are riskier. But they wised up as they realized that stocks dividends grow. Similarly people have realized the advantages of stocks and everyone and their dog knows that stocks are a primary building block of retirement portfolios. There is a huge industry that developed to educate, provide automatic workplace retirement plans, etc. Now I dont think people would need as much equity risk premium as in the past. Instead of 6.5% they might settle for 4%. So valuations can and should be higher than the past.

True, which complements the previous point. You are, correctly, staying that the higher prices are rational. But that does not imply that returns from here will be as good as the past, but rather it implies the opposite. With these higher valuations, we have lower earnings yields and so business will have lower returns from equity investments (either buying their own stock, or the stock of other firms, both having to be purchased at higher multiples than the distant past and so receiving less business (less earnings) for each dollar invested). Businesses also provide lower dividend yields, and both sources of investment contribute to lower returns even if these higher multiples are retained forever. If adapting these points to my previous post, it should slightly lower one's expectation for future returns further again.

- Manlobbi

* High valuations produce lower returns even if the high valuation is retained and not returned to lower level. This is because the lower yields continuously produce a lower return for each dollar invested. Let us say we live in a world in which the CAPE ratio would remain at 60 (valuations twice what they are today), and remaining at that high level forever. We could assign any argument to state that the higher price is rational. Both the dividend yields (per dollar invested) would then only return half what they formerly returned, and buybacks and other investment purchases would only receive half the amount of business per dollar invested. Conversely, if stocks were to be permanently priced at one quarter the present multiple, and they retained that level for the next 40 years, our returns would be enormously larger - we would experience a much sharper compounding effect also. The lower valuations (higher yields) in the first half of last century contrived to this 6.5% total return, which we are unlikely to enjoy into the future even if multiples do not return to a lower level at some point, but are simply retained. We can affirm that the higher multiples today are rational, but this does not escape us from the future returns being lower than the past even if these higher multiples were to be retained forever, which shouldn't be assumed also.

** Corporate taxation policy has also trended down for a few decades, and for that trend to continuing you would have to go from a very low tax to zero towards a zero or negative tax, which won't happen. Tax policy can trend upward again at some point, as it did in the past. We also have experienced a gradual reduction of regulation (especially wage conditions such as the minimum pay declining in real dollars). If the low tax policies or low regulation policies are merely retained, then expect a new tailwind for business that did not exist over the past few decades. This is not intuitive, but if conditions were in the past changing for the benefit of business, then merely having these conditions no longer changing but simply retained (time derivative moves from positive to zero) then this actually produces a business tailwind. If the conditions revert to the past (time derivative moves negative) then the tailwind is much harsher.

First of all. . .

Thank you thank you thank you for creating this forum. I am running screaming from TMF's new website & service model. I feel incredibly blessed to have stumbled onto this place.

Second: I have been agreeing with the general thrust of this post for most of the past 20 years. So I've been under-invested in stocks, and emphasized value over growth, much to my detriment.

Yet I can't shake the fundamental conviction that you are absolutely on target. So I continue to follow my asset allocation strategy, underweight stocks (at least I can get some return on bonds now!), and wait for better opportunities. Also, on the bright side, my asset allocation strategy led me to increase my exposure to stocks by 20 percentage points in late 2022. But since this year's rally, I just look and shake my head again.

Second: I have been agreeing with the general thrust of this post for most of the past 20 years. So I've been under-invested in stocks, and emphasized value over growth, much to my detriment.

Even if ones agrees that stocks are significantly overvalued, it is not a logical conclusion to have a low allocation to stocks. It, instead, merely implies that the expected return should be much lower than starting from a period without this overvaluation. The distinction is important.

Reducing one's allocation usually assumes entry at a lower quote, which is difficult to do for quite separate reasons: (1) [regarding missing out] The tide continues to rise, even whilst the waves are moving up and down - so the lower quote may never occur, and (2) [regarding not getting back in] even if you wait for lower quote and successfully observe it, you are prone to continue to stay out of the market in anticipation that the quote still hasn't fallen enough. The latter occurs more than one expects especially given that the news stories are worse during such a future period of lower quotes.

- Manlobbi

Manlobbi,

When I first read your post, the impression I got was one of overwhelming bearishness. Probably not what you intended.

My point is that lower returns going forward does not mean stocks are overvalued. That lower returns are what we should rationally expect. So I agree with your 2nd post.

Grantham, Hussman, et all use the 6.5% real return as some sort of divine right that god bestowed upon investors and if expected returns are lower than that, stocks must be overvalued. I think that sort of thinking caused as much damage to investors as any of the ponzi/crypto/meme stock craziness.

Thank you!

Some say that one important factor in the rise and fall of stock markets is the FED's balance sheet. Stocks tend to rise with QE (Quantitative easing) and fall with QT (Quantitative tightening).

This link gives a good idea of the impact of QE and QT : https://fred.stlouisfed.org/graph/?graph_id=110219... (that formula is borrowed from someone on Twitter, can't remember his name at the moment). There is a giant jump in 2020 and that matches the rise of stocks. The peak in Sept. 2021 was not far from the top of the market. Add the rise of the interest rates and that seems to explain the bear market.

If this relationship continues between the FED's balance sheet and the markets, then the following years could be bumpy as the FED said they wanted to reduce their balance sheet. But all we need is a recession for them restart QE...

Fantastic discussion, thank you to everyone who's contributed.

For my money any potential investment has to compete against the risk-free return rate.
So as of today, you could purchase a 1Year T-Bill that will return 4.93%, a sleep easy, boring, (I like boring!) no stress return.
Or you could purchase the S&P 500 with a P/E of 21.8, and an earnings yield of 4.59%.
Of course the decision is yours, based on your need, willingness and ability to take risk.
That said, stocks are pricey, no one can deny that.(Even in this thread we've been given examples of why stocks should be pricey.)

Valuations do matter for the long term investor'
Over the last 100 years the S&P 500 took three long, interesting trips to nowhere,
underperforming risk-free Treasury bills for 53 of those 100 years (1929-1945, 1959-1982, and 1995-2009).

Are we setting up for another one of those periods where Treasuries outpace equities?
(All these episodes began with stocks selling for 20X earnings or better, much like today.)
I asked my Lucky 8 Ball for the answer and it said, 'Most Likley.'
So there you have it, make sure your seat backs and tray tables are in their full upright position!

I'll leave you with a chart I keep on my desk, it shows the inevitable oscillation
between greed and fear (overvaluation and undervaluation) that we investors have been continually replaying ever since Lucy stood upright'

https://upload.wikimedia.org/wikipedia/commons/4/4...

Where do you think we are currently? Enthusiasm, Denial, Bull Trap?
Stay tuned for the answer!

All The Best!

"Where do you think we are currently? Enthusiasm, Denial, Bull Trap?"

"Return to Normal"?

The price to book value is a completely different way of looking at the valuation,
and on this measure we are also 47% overvalued compared to the data back to 2000
(which is a period that on the whole has been a fairly optimistic, and thus low yielding).
Price to book values have been much lower prior to 2000.

Simplistic rules of thumb like price to book can be quite misleading.

For example...

The ratio of tangible investments to intangible investments in the US was about 2 to 1
prior to the 1990s. Around the end of the 1990s they began to converge. After 2000, the
trend has been in the opposite direction -- investment in intangibles has increasingly
outweighed investment in tangible assets. In 2020, investment in intangibles was more than
double investment in tangibles.

Tangible investments show up as assets on the balance sheet. Intangible investments show
up as expense on the income statement, unless they were acquired. This means book value is
being understated nowadays because these intangible investments are not showing up on the
balance sheet. And because intangible investments now significantly outweigh tangible
investments, it's material. Historical comparisons of price to book thus become problematic.

Ears

Tangible investments show up as assets on the balance sheet. Intangible investments show
up as expense on the income statement, unless they were acquired. This means book value is
being understated nowadays because these intangible investments are not showing up on the
balance sheet.

Could you please give an example of intangible investments?

TIA,

IP

Could you please give an example of intangible investments?

Sure.

Pfizer had 89 active projects as of February 2022 for research and
development of drugs. These projects can take as much as 10 years
before getting to market. Some of them will never make it to market.
The expense associated with these projects will appear on the income
statement even though any benefits won't be realized for many years,
if at all. These development activities are intangible -- they're not
physical like a factory or store.

Ears

Quick update:

As of today that boring 1YR T-Bill is yielding 5.03% VS the S&P500 earnings yield of 4.54%. https://www.multpl.com/s-p-500-earnings-yield
The CNN Greed/Fear Index is reading GREED. (Greed is good! Right?)
The Buffett indicator is @157% of GDP.
The S&P500 P/Sales is about 2.4. (It hit 0.80 in March 2009 as the bear market bottomed, if you'd like an idea of what is possible.)

Interesting times!

But don't fret, I recently read this online...

"Those crusty old valuation tools no longer apply, it's the age of Crypto Baby!"

All The Best!

Anybody here have experience using Vanguard Brokerage Services to buy T-Bills I have used Vanguard to buy and sell Indiv stocks, ETFs and mutual funds for 30 plus years but haven't seen any option anywhere to purchase a T-bill.

Maybe it trades like a stock, I place a market order for 100 shares of 52 week Treasury Bills and that order fills at the next auction for a cost of the $100,000 face less the discount rate representing the current auction's interest rate. All that would be fine provided the 52 week T-Bill has a symbol that I can buy 100 of. But I can't seem to find that "symbol" so there must be some other mechanism.

I understand I could open a Treasury Direct Account and that would fine for my taxable investments. But I also would like to buy within my Roth. Reading on Treasury Direct web site, I didn't see an option for them to be a Roth Custodian. I looked on Vanguards website at it implies it can be done but doesn't explain how. Hence my question to board. TIA for any info.

'As of today that boring 1YR T-Bill is yielding 5.03% VS the S&P500 earnings yield of 4.54%.'

Despite the relatively higher Treasury rates recently, I am still underwhelmed wrt the real yield as it compares to the 'equity coupon' of equities like BRK or solid S&P companies returning 10%+ ROE when looking to hold for a time frame of 5+ years.

<Despite the relatively higher Treasury rates recently, I am still underwhelmed wrt the real yield as it compares to the 'equity coupon' of equities
like BRK or solid S&P companies returning 10%+ ROE when looking to hold for a time frame of 5+ years.>

Agree 100% on the Berkshire!
But since this is the Index Investing Board, I'm just pointing out the historically high valuation levels of the S&P500 Index. (As Manlobbi mentioned earlier in the thread.)
Not just compared to T-Bills BTW, also using P/E, Schiller P/E, P/Book, P/Sales, Trendline, Buffett Indicator etc, etc.

Or perhaps...

"Stocks have reached what looks like a permanently high plateau." ~Irving Fisher

All The Best!

Regarding Vanguard,you can purchase Treasuries on their website but not from the app.

From any account,select Transact. At the bottom of the list of instruments, select Trade bonds or CDs. You will then need to re-select the account.

On the next page select the Treasuries tab. It defaults to Secondary but I have only used the Auction option (radio button).

You will then be given a choice of issues to purchase. If there is no 'buy' link on the left the issue is not available yet.

Hope this helps.

I use Charles Schwab, but if you click the link below and scroll down to Vanguard (the link might automatically scroll down for you), I believe you will find what you are looking for.

https://thefinancebuff.com/treasury-bills-cd-money...

use Charles Schwab, but if you click the link below and scroll down to Vanguard (the link might automatically scroll down for you), I believe you will find what you are looking for.

https://thefinancebuff.com/treasury-bills-cd-money...

--------------------

Thank You Troy. That link provided exact and detailed steps to take with Vanguard. I just navigated Vanguard and the description matched the website exactly. I successfully entered an order to buy a $25,000 one month bond to get a feel for the process. It settles on 02-28 and matures on 03-28. The estimated yield was 0.2% higher than the money market where my cash is currently parked. After completing this round trip, I will make a bigger buy in April.

Thanks again for the info.

Over the last 100 years the S&P 500 took three long, interesting trips to nowhere,
underperforming risk-free Treasury bills for 53 of those 100 years (1929-1945, 1959-1982, and 1995-2009).


That is an extremely misleading way to state things.
It seems to say that S&P 500 underperformed treasury bills for 53 years. Not at all true.
So many wrong assumptions, I don't want to try and point out all of them here.
Bottom line, one can safely ignore this lie, damn lie, and statistic.

Post New

Berkshire Hathaway FAQ

---

Contact Shrewd'm
Contact the developer of these message boards.